Easy Lending to Risky Borrowers Makes a Comeback

Rates are low, credit is easy, underwriting is shoddy, and sales are booming.

There’s your thumbnail sketch of today’s “surging” auto market. It’s a carbon copy of the subprime mortgage fiasco that plunged the economy into recession 5 years ago. Now the same nightmare is unfolding in Cartopia, the emerging credit Shangri-la where anyone who can transport himself onto a carlot in an upright position can drive away in a shiny new vehicle no-strings-attached.

But how can this be happening, you ask? Didn’t the US Congress pass strict new regulations, like Dodd-Frank, to prevent the banks and finance companies from lending billions of dollars to borrowers who don’t have the ability to repay the debt?

Not exactly. The fact is, the powerful auto lobby snuck in a neat little provision that exempted them from those nitpicky rules. Here’s a little background from Slate’s Matthew Yglesias:

“Measures like the CARD Act and the Dodd-Frank bill’s creation of a Consumer Financial Protection Bureau both tilt in the direction of less consumer debt. But the wide dispersal of car dealerships across almost every congressional district in America means that the car dealership lobby is actually stronger than the Wall Street lobby, and it was able to get a special carve-out from Dodd-Frank. Unlike any other form of consumer lending, auto loans are outside the purview of the CFPB. And they’re expanding while other consumer loans are shrinking.” (“The Changing Shape of American Debt“, Matthew Yglesias, Slate)

Gosh. You mean Congress buckled to the power of big money? That’s shocking!

And now it looks like we got trouble on our hands because auto sales are soaring but a lot the loans are never going to be repaid. Isn’t that going to wreak havoc on the financial system again?

Sure, but let’s look on the bright side: Auto sales are up big, really big. In fact, according to the Wall Street Journal “U.S. auto sales in November ran at the strongest pace in more than six years… lifting the annualized sales pace to 16.4 million vehicles.” (WSJ)

Chrysler is up, Ford is up, Malibu is up, Cadillac and Buick are up. Heck, even the pint-sized Volt is up. Everything’s up; autos, trucks, SUVs, the whole kit-n-kabootle. Detroit is this year’s Comeback Kid and it’s all due to creative financing. Isn’t that reason-enough for celebration?

Sure, but doesn’t it seem a tad reckless to lend gobs of money to people with crappy credit scores who can’t even come up with a few hundreds bucks for a down-payment? That sounds like a prescription for disaster to me. Just look at this from Reuters:

“Lenders made 26.04 percent of their loans on new cars to buyers with subprime credit scores…. For loans on used cars, the portion to subprime borrowers rose to 54.95 percent…

As the lenders made bigger loans, they also extended credit further beyond the value of the vehicles. The average loan-to-value on new cars rose to 110.6 percent… On used cars it rose to 133.2 percent…

Auto lenders often provide loans that exceed the value of cars they are financing because borrowers want cash to pay sales taxes and fees.

Extra-long loans are becoming more common. Some 19 percent of new car loans were made for more than six years…

Car dealers are not only skipping the down payment and extending the loan into the next millennia (more than 6 freaking years, for chrissakes), they’re also forking over MORE money than the value of the car. That’s what that “133.2 percent” LTV means. It means Mr Subprime Autobuyer can stick a wad of cash in his coat pocket after the ink dries and trundle off to Olive Garden with the kids for a night on the town in his brand-spanking new Impala.

Who said Amerika isn’t a great place? Here’s more from Bloomberg:

“A woman came into Alan Helfman’s showroom in Houston in October looking to buy a car for her daily commute. Even though her credit score was below 500, in the bottom eighth percentile, she drove away with a new Dodge Dart. A year ago, “I would’ve told her don’t even bother coming in,” says Helfman, who owns River Oaks Chrysler Jeep Dodge Ram, where sales rose about 20 percent this year. “But she had a good job, so I told her to bring a phone bill, a light bill, your last couple of paycheck stubs, and bring me some down payment.”

… U.S. auto sales, on pace for the best year since 2007, are increasingly being fueled by borrowers with spotty credit. They accounted for more than 27 percent of loans for new vehicles in the first half of the year…

“Perhaps more than any other factor, easing credit has been the key to the U.S. auto recovery,” Adam Jonas, an analyst with Morgan Stanley (MS), wrote in an October note to investors.” (“Subprime Loans Are Boosting Car Sales“, Bloomberg)

Sure, it has, Adam, because easy credit means better sales and bigger profits. We all know that. Just like we know that it’s possible to lend money to people who have “spotty credit” if they show that they’re employed and paying their bills on time, like the woman above. But that’s not what this is all about, is it? This is about stretching the envelope in order to juice short-term profits. It’s also about “securitization”, that is, packaging up the garbage loans into bonds and selling them to suckers looking for a higher yielding investment. That’s what this is really about; scamming people. Take a look at this from Bloomberg:

“The money for subprime loans comes from yield-starved investors who buy bonds backed by them. Issuance of such bonds, which pay higher rates than U.S. government debt, soared to $17.2 billion this year, more than double the amount sold during the same period in 2010, but still below the peak of about $20 billion in 2005, according to Harris Trifon, an analyst at Deutsche Bank ….

Shoddy home loans packaged into bonds by Wall Street banks fueled the financial crisis. Subprime auto loans are a good investment, Helfman says: “A person that has to get from point A to point B, they’re not going to jeopardize their job. They have to pay the car payment before they pay anything else.” (Bloomberg)

How’s that for symmetry: In one breath Bloomberg admits that “Shoddy home loans … fueled the financial crisis”, then they follow up with old Helfman saying there’s nothing to worry about, everything’s under control. We gotcha covered!

What a joke. More than one-quarter of auto loans are going to people with credit scores under 500, which “is the highest share since tracking began in 2007.” That’s a big red flag right there. Then, a sizable portion of those loans are being gift-wrapped into securities and sold to Aunt Mable’s retirement fund, which will undoubtedly get walloped sometime in the not-so-distant future. That’s red flag Number 2. Finally, there’s the dealer mark ups which, according to one analyst add “several percentage points above what they obtain from their financing company, which generates an estimated $25.8 billion in payments from consumers over the lives of their loans.” Red flag number 3.

I suppose we should all be shocked that the finance geniuses are back at it again, back fleecing the sheeple with the same swindle they worked before. But the sad fact is, no one is surprised at all. In fact, the public seems oddly resigned to the idea of being ripped off again.